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Is The Correction Over?

Tyler Durden's picture




 

Submitted by Lance Roberts of STA Wealth Management,

A couple of week's ago I asked the question "How Big Could A Correction Be?"  In that article, I compared several different technical models to establish potential correction levels which derived the following table of probabilities. Of course, as I stated at that time:

"There is no exact answer to the potential magnitude of a correction in the markets. 'This' depends on 'that' to occur which is why trying predict markets more than a couple of days into the future is nothing more than a 'wild ass guess' at best. However, from this analysis, as shown in the table below, we can make some reasonable assumptions about potential outcomes."

S&P-500-CorrectionTable-080614

As shown in the chart below, the recent correction fulfilled the correction to the 2013 bullish trend and got oversold (yellow highlights) on a very short term basis.

SP500-TechnicalUpdate-081814

With the markets opening higher today, it appears that the short-term correction in the markets may be over as the "buy-the-dip" mentality remains firmly entrenched with market participants.

However, if we step back from the day-to-day volatility by looking at weekly data, a different picture emerges.

SP500-TechnicalUpdate-081814-2

As shown, the market registered a signal in early January to reduce equity exposure in portfolios. Importantly, while this does not mean selling everything and running into cash, it does suggest that the markets are egregiously overbought on a short-term basis and investors should rebalance holdings in portfolios.  This is done by "trimming winners," reducing holdings back to original portfolio weights, and "selling laggards," which reduces portfolio drag and provides future portfolio tax efficiencies.

After the initial sell signal in January, the market primarily traded sideways for the next several months, with a good bit of volatility along the way. The reduction in portfolio risk reduced overall portfolio volatility with only a minimal drag on overall performance. However, should if the markets had dropped into a deeper correction, investors would have been well positioned to "buy." However, in May, the markets broke out of the consolidation range and the "all clear" signal was given to increase equity risk in portfolios. The consolidation process also allowed for a lower risk entry to add back additional equity exposure.

This process is once again likely being repeated. At the end of July, the markets once again suggested the investors should revisit portfolio holdings and adjust risk accordingly. However, as I stated in the newsletter two weeks ago:

"Furthermore, by the time a WEEKLY sell signal is issued the markets are generally OVERSOLD on a short term basis. It is very likely, that a rally will ensue in the markets over the next week back to resistance which could be used to rebalance portfolios and reduce risks more prudently."

That bounce has now occurred which would suggest that this is a good time to revisit portfolios and make allocation adjustments.

Like gardening, good portfolio management practices consist of processes to "weed and prune."  If weeds are not pulled and plants go unpruned, eventually the bounty will rot on the vines, and the weeds will choke the plants out of existence.  The same happens in portfolios. Individuals do not "prune" winners, by taking profits and rebalancing, until a significant correction occurs which erases most or all of their gains.  Likewise, "losers" are held in portfolios "hoping they will come back." Eventually, individuals wind up with a portfolio full of "weeds" with only memories of the gains they once had.

Outlining The Risks

While the markets are currently suggesting that the "dip" is over, there are several immediately prevailing risks that could catch unwitting investors.

1) The contraction in both Japanese and Eurozone economies.

40% of corporate profits come from international trade. The pop in revenue and profits in the second quarter was not surprising given the drawdown in activity during the Q4 and Q1.  However, since the end of the financial crisis the economy has been plagued by sluggish economic growth characterized by rolling recoveries and declines. With retail sales extremely sluggish, imports weak and exports at risk of decline, the impact to both profits and economic data could push markets lower.

2) Mid-term Elections.

The markets like "gridlock" in government as it eliminates the risk of adverse fiscal policies. However, there is a rising probability that conservative Republicans could gain control of the Senate while maintaining majority control of Congress. The impact of such an outcome could be negative for the markets as it increases the probabilities of drastic cuts in government spending, reductions/reform of entitlement programs, and potential repeal, or "fix," of the Affordable Care Act (ACA).  While moves to a more fiscally responsible government would provide longer term benefits, such actions would likely trigger an economic recession and stock market correction.

3) Hard landing in China.

Nouriel Roubini recently wrote: "The rebalancing of growth away from fixed investment and toward private consumption is occurring too slowly, because every time annual GDP growth slows toward 7%, the authorities panic and double down on another round of credit-fueled capital investment. This then leads to more bad assets and non-performing loans, more excessive investment in real estate, infrastructure, and industrial capacity, and more public and private debt. By next year, there may be no road left down which to kick the can."

4) Extraction of monetary accommodation by the Federal Reserve

Currently, the markets are still being assisted by the ongoing interventions of the Federal Reserve. As shown in the chart below, via @sobata416,  the advances in the market have been closely correlated with Fed's liquidity operations. With that support most-likely ending in October, the risk for equities remains to the downside.

SP500-FedBalanceSheet-081814

Furthermore, risks of a market correction begin to increase markedly once the Federal Reserve begins raising interest rates.

5) Deflation isn't dead

Despite the Federal Reserve's best intentions to create inflation in the economy, the deflationary pressures on the economy have not yet been vanquished. Wages remain under pressure, employment is muted and primarily a function of population growth, monetary velocity remains extremely tepid and commodity prices have fallen.  The following chart was discussed in detail in "Will The Fed Move Too Soon."

High-Inflation-Index-080514

"With deflationary pressures from overseas still prevalent, it is very likely that the current uptick in inflation may be fleeting. This potentially could put the Fed at 'risk' of moving too soon to extract support from the economy and beginning to increase interest rates in anticipation of stronger growth."

Something Worth Thinking About

While it is entirely possible that the recent "correction" in the market is over, it is important to remember that what goes "up" must eventually come "down." Despite the best of intentions by Wall Street and the Federal Reserve to ensure that a correction "never" happens again, the reality is that the laws of physics apply to stock market prices just as much as Newton's apple.

The question that you have to reconcile with yourself is:

"When the market does eventually break, will you be prepared?"

History clearly shows that few ever are. While the process of "weeding and pruning" may sound a "bearish" in an overwhelmingly "bullish" environment, the greatest investors in history have all had a disciplined risk management process embedded within their long-term investment strategy. While it sounds simple, "buying low and selling high" is extremely hard for most to do.

 

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Mon, 08/18/2014 - 14:56 | 5109946 hedgeless_horseman
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Importantly, while this does not mean selling everything and running into cash, it does suggest that the markets are egregiously overbought on a short-term basis and investors should rebalance holdings in portfolios.

More importantly, there are no more markets or investors, dumb fuck.  There are now only banks buying each other's debt, equity, and derivitives, company's buying back their own stock, and software programs front-running other software programs for a tiny fraction of a fraction of a penny.

Mon, 08/18/2014 - 14:58 | 5110052 BandGap
BandGap's picture

I started reading this and all I could think is "you have to be fucking kidding me".  What kind of fucking correction are they referring to?

Like a 450 pound tub of shit saying it's OK to resume eating after losing 10 pounds.

This has to be a dream, this shit isn't real and no one can convince me otherwise.

Mon, 08/18/2014 - 15:28 | 5110221 max2205
max2205's picture

As long as there are POMO's....BTFD!

Mon, 08/18/2014 - 15:37 | 5110280 Market Rage
Market Rage's picture

That was pretty funny.

Mon, 08/18/2014 - 15:00 | 5110068 SilverIsKing
SilverIsKing's picture

The decision to keep propping up the market is always an easier one than letting it go to shit so that's what they will do.

Forever...until the USD blows up.

Mon, 08/18/2014 - 15:24 | 5110199 theonewhowaskazu
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Furthermore, risks of a market correction begin to increase markedly once the Federal Reserve begins raising interest rates.

Risks of a market correction begin to increase markedly IF the Federal Reserve begins raising rates.

Mon, 08/18/2014 - 14:42 | 5109947 Hohum
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> Will first rise (S & P) 10% from here

> Will first fall 10% from here

Mon, 08/18/2014 - 14:44 | 5109958 ebworthen
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Pretty sure non of these technical models take into account insane FED propping of risk and leverage.

The FED would have to end QE and backdoor lending - then set the prime rate at 6% - to restore validity to any of these models.

Mon, 08/18/2014 - 14:45 | 5109968 i_call_you_my_base
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They also don't take into account fraud or riggings.

Mon, 08/18/2014 - 14:46 | 5109974 GrinandBearit
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It's over the very second ZH posts any type of "the market is crashing" headlines.

 

Perfect contrary indicator.

Mon, 08/18/2014 - 15:24 | 5110201 Let them eat iPads
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We'll get to read another 5000 such "market is crashing" stories from ZH before the market actually DOES crash.

Then they'll finally be right.

Mon, 08/18/2014 - 15:36 | 5110276 peterpilot9
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I have been a loyal reader of ZH since I discovered it in 2010.  I was amazed at how wrong the posts here have been in regards to the market.  They laugh, mock and ridcule the bozo's at CNBC but in the end analysis, Bob and his gang of Cramers have been, well, more correct.

Of course, the call of the Hedgers back in the day to go off the grid, dig bunkers in the back and stock them with beans, bullets and bullion has also become more muted over time.  Very entertaining place is this Hedge but me thinks people here take the information provided far more seriously that the site's track record would indicate should be the case.

Mon, 08/18/2014 - 15:56 | 5110383 BandGap
BandGap's picture

A paradigm shift is just that. Once it happens, there will be no going back to this insanity for at least another 60 years. Then we repeat the cycle in another form.

But change it will. If you have only one shot to do the right thing, well, I tend to start early. Maybe you'll time it better. Good luck.

Mon, 08/18/2014 - 16:16 | 5110496 GrinandBearit
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It's not that they are fundementally correct, they're simply betting that the Fed's trillion dollar funny money injections will never stop.  The CNBC/Bloomberg/FOX bozos are all instructed to be bullish.. if not, they have no job.  Algos, stock buy backs, POMO, and tons of other shit going on behind the curtain.  Muppets like us are only privy to a fraction of what is really going on.  

Mon, 08/18/2014 - 18:02 | 5110989 i_fly_me
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The Hedgers will only have to be correct once.  The bozos have to keep this up forever.

Mon, 08/18/2014 - 14:47 | 5109979 slightlyskeptical
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Charts say buy until we pass old highs.

Mon, 08/18/2014 - 14:54 | 5110026 SheepDog-One
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My bowl of chicken entrails says 'Buy, but only 25+ P/E.'

Mon, 08/18/2014 - 14:47 | 5109981 Rompoculos
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"Nothing is over! Nothing! You just don't turn it off!"

Mon, 08/18/2014 - 14:52 | 5110016 SheepDog-One
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I don't believe for a second the Fed is easing out of its last 5 years of total support and rigging and now things are floating along on their own, 'markets getting their legs back' nonsense.

Mon, 08/18/2014 - 14:58 | 5110047 valley chick
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Ageed as any tapering would be seen in the bond market. Same as it ever was...including lies.

Mon, 08/18/2014 - 15:00 | 5110069 Winston Churchill
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They can't. Take the economic corpse of the FedRes life support, and all

thats left will be the burial. The FOMC does not want their necks stretched as

a by product.

The next thing to crash will be the USD and I'm thinking its not just europe that has to

worry this winter. The BRICS need to wrap this up quickly while they still have an incompetent

in the White hut.

Slowly at first, then all at once.

Mon, 08/18/2014 - 15:02 | 5110070 Winston Churchill
Winston Churchill's picture

They can't. Take the economic corpse off the FedRes life support, and all

thats left will be the burial. The FOMC does not want their necks stretched as

a by product.

The next thing to crash will be the USD and I'm thinking its not just europe that has to

worry this winter. The BRICS need to wrap this up quickly while they still have an incompetent

in the White hut.

Slowly at first, then all at once.

Mon, 08/18/2014 - 14:59 | 5110054 debtor of last ...
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GAAP accounting means YAWN accounting where i come from. And no, it's not Zimbabwe.

Mon, 08/18/2014 - 14:59 | 5110055 SickDollar
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Stock Market Crash is Not Inevitable period


Mon, 08/18/2014 - 15:02 | 5110073 SheepDog-One
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People will just wake up one day to find their 'balanced portfolios' have been Corzined.

Mon, 08/18/2014 - 15:04 | 5110082 Steroid
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Stock Market Crash is Not Inevitable period, period

Mon, 08/18/2014 - 15:01 | 5110066 rubearish10
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Correction?? Really??? More like just another shallow 5% for a moment "pullback", right? Correction = 10% off highs, Bear market = 20% off highs, BTFD = anything less than above, dammit!

Mon, 08/18/2014 - 15:06 | 5110097 SheepDog-One
SheepDog-One's picture

That's all I see, just a little dip to let some air out to apply more duct tape to a problem spot then reinflate the balloon....what 'correction'? Nonsense.

Mon, 08/18/2014 - 15:03 | 5110076 sosoome
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It depends on the meaning of the word "down".

Mon, 08/18/2014 - 15:03 | 5110079 esum
esum's picture

markets are one thing.... what about banks.... who tallies all the counterparty risk and how it can ripple through the system AGAIN.... and what will trigger it THIS TIME.... nothing has been fixed more fucked up than ever.... regulation lags reality and tries to catch up ... idiots chasing geniuses... geniuses who OWN POLITICIANS and JUDGES...globally

Mon, 08/18/2014 - 15:19 | 5110171 Itchy and Scratchy
Itchy and Scratchy's picture

What correction?

Mon, 08/18/2014 - 15:25 | 5110206 Wait What
Wait What's picture

i can't believe ppl actually get 2 & 20 for drivel like this.

i could have said the same thing & been 1/10 as verbose.

"there will be no corrections of >5% cuz financials can't sustain the losses."

the only thing that stops the ascent of this financial bubble is a global catastrophic event, most likely involving EMPs that fry comms & prevent the trading of securities. nothing else matters to honey badger

Mon, 08/18/2014 - 15:27 | 5110216 Goldbugger
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Correction? That was no stinking correction. Here's whats coming up in a few months.

The Jaws of Death will commence and the FEDs people will not put the economy back together again.

look at chart two for the longer picture and chart thre for what's about to happen. Let's just thank the FED for creating this mess, then trying to fix it and FUBARing everything.

http://elliottwavepredictions.com/

 

 

Mon, 08/18/2014 - 15:30 | 5110240 GFORCE
GFORCE's picture

As the old saying goes: "The markets are never wrong".

You may not agree with these levels and the fundamentals maybe don't line up, but there's still buyers out there and for reasons that you can't grasp. 

Mon, 08/18/2014 - 15:31 | 5110244 thismarketisrigged
thismarketisrigged's picture

what fucking correction has there been?

 

the s&p fell what, 3 percent or so, big fucking deal.

 

of course they were able to fucking pump it straight up in a straight line back to where it fell from with zero volaitlity whatsoever.

 

anyone who believes this is a market, i have ocean front property in missouri to sell to u

Mon, 08/18/2014 - 15:37 | 5110275 Godisanhftbot
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 The bitcoin correction ends at ZERO, which , coincidently , is fair value

Mon, 08/18/2014 - 15:37 | 5110278 Godisanhftbot
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  ZH has been corrected for 5 years, every time the market doesn't evaporate.

Mon, 08/18/2014 - 15:39 | 5110287 TheRideNeverEnds
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I like those oscillators, they show clearly that every time the market is indicated as oversold it goes higher and nearly every time it is over bought it goes higherer.  

Mon, 08/18/2014 - 18:18 | 5111081 scubapro
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until it doesnt.  the most dramatic market corrections are when the mkt already looks oversold, then it gets worse.

what this guy is saying, is he doubts a near or shorter term (less than 6 months)  down move is over.  

it rarely goes from all time highs to straight down, just look at 2006/7 and 2000/1   back and forth, one index then another and then they all look like they are about to move higher etc.   

a 10% down move followed by 5% up which might take 2-3 months is a change in trend; then another 15% down move followed by 8% up.    that kind of action will kill the people (former bulls who 'panic')  as they sell into/at each bottom turn then buy higher (b/c theyre perma bulls) will drive them insane yet the net move in the mkt will only be net -12%  and the 'lesson' will be 'dont try to time the mkt'.    

But i think the author is trying to say Be Prepared as in, mentally prepared.  sell some now wait for drop, maybe buy if you 'need' to; sell into strngth etc.      if one is not metally prepared for a 18 month downtrend with these vascillations, it will be very uncomfortable.

Mon, 08/18/2014 - 15:43 | 5110314 sunny
sunny's picture

"When the market does eventually break, will you be prepared?"

 

Faber has been calling for a major crash every 3 or so months for the last 3 or 4 years.  Hussman, and many others as well.  The markets won't crash as long as we have ZIRP.  I wish folks would quit saying otherwise.  It's getting old.

Mon, 08/18/2014 - 15:51 | 5110351 J Pancreas
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ZH provides many people's viewpoints. Tyler and co. don't sit around all day on their ham radios or lay boobie traps in front of their houses or apartments. To the fucks above who are criticizing the one place where truth and uncorrupted debate can take place online I say leave and don't let the door hit you on the way out. Sorry you blew your wad shorting the sp but it isn't the Hedge's job to trade or invest for you. Its simply to put forth a viewpoint that is likely contrary to what our handlers would have us believe.

Mon, 08/18/2014 - 17:25 | 5110798 Rouge Trader
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Contrarians get proven right eventually. Timing is just such a bitch. 

Mon, 08/18/2014 - 19:07 | 5111360 limacon
limacon's picture

I have not yet begun to fight! John Paul Jones

His attitude to "corrections"

Do NOT follow this link or you will be banned from the site!